1.3 Agency theory and the role of corporate governance

Question 1

What is “agency theory”?

Answer 1

Theory whereby modern corporations are based on the principal-gent theory. The owner (shareholder) is the principal and the manager (directors) the agent.

Question 2

What is the “principle-agent problem”?

Answer 2

In a principle-agent relationship, conflicts of interest may arise, whereby the agent’s interests are not aligned with those of the principle.

Question 3

What are agency costs?

Answer 3

Costs incurred by the inefficiency of a relationship between shareholders and business managers. For example, auditors fees.

Question 4

What is the key objective of external audit?

Answer 4

To protect the principal by independently reporting on the state of the company’s finances.

Question 5

What is corporate governance?

Answer 5

A set of internal rules, policies and processes that determine how a company is directed.